Equilibrium in AD-AS Model Problem Set

Transcription

1 Equilibrium in AD-AS Model Problem Set 1. Describe the short-run effects of each of the following shocks on the aggregate price level and on aggregate output. Illustrate using a properly-labeled graph. a. The government sharply increases the minimum wage, raising the wages of many workers. b. Solar energy firms launch a major program of investment spending. c. Congress raises taxes and cuts spending. d. Severe weather destroys crops around the world. 2. Suppose someone says, Using monetary or fiscal policy to pump up the economy is counterproductive you get a brief high, but then you have the pain of inflation. Explain what this means in terms of the AD-AS model.

2 3. There were two major shocks to the U.S. economy in 2007, leading to a severe economic slowdown. One shock was related to oil prices; the other was the slump in the housing market. This question analyzes the effect of these two shocks on GDP using the AD-AS framework. a. Draw typical aggregate demand and short-run aggregate supply curves. Label the horizontal axis Real GDP and the vertical axis Aggregate price level. Label the equilibrium point E1, the equilibrium quantity Y1, and equilibrium price P1. b. Data taken from the Department of Energy indicate that the average price of crude oil in the world increased from $54.63 per barrel on January 5, 2007, to $92.93 on December 28, Would an increase in oil prices cause a demand shock or a supply shock? Redraw the diagram from part (a) to illustrate the effect of this shock by shifting the appropriate curve. c. The Housing Price Index, published by the Office of Federal Housing Enterprise Oversight, calculates that U.S. home prices fell by an average of 3.0% in the 12 months between January 2007 and January Would the fall in home prices cause a supply shock or demand shock? Redraw the diagram from part (b) to illustrate the effect of this shock by shifting the appropriate curve. Label the new equilibrium point E2, the equilibrium quantity Y2, and equilibrium price P2. d. Compare the equilibrium points E1 and E2 in your diagram for part (c). What was the effect of the two shocks on real GDP and the aggregate price level (increase, decrease, or indeterminate)?

3 4. Using aggregate demand, short-run aggregate supply and long-run aggregate supply curves, explain the process by which each of the following economic events will move the economy from one long-run macroeconomic equilibrium to another. Illustrate with diagrams. In each case, what are the short-run and long-run effects on the aggregate price level and aggregate output? a. There is a decrease in households wealth due to a decline in the stock market. b. The government lowers taxes, leaving households with more disposable income, with no corresponding reduction in government purchases. 5. The economy is in short-run macroeconomic equilibrium at point E1 in the accompanying diagram. Based on the diagram, answer the following questions. a. Is the economy facing an inflationary or a recessionary gap? b. What policies can the government implement that might bring the economy back to long-run macroeconomic equilibrium? Illustrate with a diagram.

4 c. If the government did not intervene to close this gap, would the economy return to a long-run macroeconomic equilibrium? Explain and illustrate with a diagram. d. What are the advantages and disadvantages of the government implementing policies to close the gap? 6. In the accompanying diagram, the economy is in long-run macroeconomic equilibrium at point E1 when an oil shock shifts the short-run aggregate supply curve to SRAS2. Based on the diagram, answer the following questions. a. How do the aggregate price level and aggregate output change in the short run as a result of the oil shock? What is this phenomenon known as? b. What fiscal or monetary policies can the government use to address the effects of the supply shock? Use a diagram that shows the effect of policies chosen to address the change in real GDP. Use another diagram to show the effect of policies chosen to address the change in the aggregate price level. c. Why do supply shocks present a dilemma for government policy makers?

5 Use the figure below to answer questions 7-9. Use the figure below to answer question In the short run, a decrease in investment is illustrated by: A. Panel (A). B. Panel (B). C. Panel (C). D. Panel (D). E. Panels (B) and (D). 8. In the short run, an increase in net exports is illustrated by: A. Panel (A). B. Panel (B). C. Panel (C). D. Panel (D). E. Panels (A) and (C). 9. In the short run, an increase in wages is illustrated by: A. Panel (A). B. Panel (B). C. Panel (C). D. Panel (D). E. Panels (A) and (D). 10. Suppose that the U.S. government doubles its spending on health care. Which of the following is most likely to occur? A. The short-run aggregate supply curve shifts right, output increases, and prices decrease. B. The short-run aggregate supply curve shifts left, output decreases, and prices increase. C. The aggregate demand curve shifts left, output decreases, and prices decrease. D. The aggregate demand curve shifts right, output increases, and prices increase. E. The aggregate demand curve shifts right, output increases, and prices decrease. 11. An increase in aggregate demand will generate in real GDP and in the price level in the short run. A. an increase; an increase B. an increase; no change C. a decrease; no change D. no change; an increase E. an increase; a decrease 12. In the accompanying figure, curve 1 refers to, curve 2 refers to, and curve 3 refers to. A. long-run aggregate supply; short-run aggregate supply; aggregate demand B. aggregate demand; short-run aggregate supply; long-run aggregate supply C. short-run aggregate supply; long-run aggregate supply; aggregate demand D. aggregate demand; long-run aggregate supply; short-run aggregate supply E. short-run aggregate supply; aggregate demand; long-run aggregate supply 13. An improvement in the business outlook of firms is a type of and therefore shifts the to the. A. positive supply shock; long-run aggregate supply curve; right B. positive demand shock; aggregate demand curve; left C. positive supply shock; short-run aggregate supply curve; right D. positive demand shock; aggregate demand curve; right E. positive supply shock; short-run aggregate supply curve; left 14. A natural disaster that destroys part of a country's infrastructure is a type of and therefore shifts the to the. A. negative demand shock; aggregate demand curve; right B. negative supply shock; aggregate demand curve; left C. negative supply shock; short-run aggregate supply curve; left D. negative demand shock; long-run aggregate supply curve; left E. negative supply shock; short-run aggregate supply curve; right 15. The intersection of the economy's aggregate demand and long-run aggregate supply curves: A. determines its equilibrium real GDP in both the long run and the short run. B. determines its equilibrium price level in both the long run and the short run. C. occurs at the economy's potential output. D. occurs at high levels of cyclical unemployment. E. occurs at the level of output that corresponds to an unemployment rate of 0%. 16. A recessionary gap occurs if: A. actual real GDP is less than potential output. B. actual real GDP is greater than potential output. C. actual real GDP is equal to potential output. D. unemployment is less than the natural rate. E. unemployment is equal to zero.

6 Use the figure below to answer questions Suppose that the initial equilibrium is at real GDP level Y1 and price level P2. At real GDP level Y1 there is: A. an inflationary gap. B. a recessionary gap. C. No cyclical unemployment. D. long-run equilibrium. E. full employment. 18. Assume that the economy depicted in figure above is in short-run equilibrium with AD1 and SRAS1. If the economy is left to correct itself: A. real interest rates will fall which will shift SRAS rightward. B. lower wages will result in a gradual shift from SRAS1 to SRAS2. C. long-run equilibrium will be established at YP and P3. D. aggregate demand will shift leftward. E. aggregate demand will shift rightward to Yp and P As an inflationary gap is eliminated through self-correcting adjustment, the equilibrium price level and the equilibrium real output. A. increases; decreases B. increases; increases C. decreases; decreases D. decreases; increases E. remains constant; decreases